Would you fund your own crop insurance program?

Crop insurance premiums for 2013 will be minimally different from last year. They will be less than 2012 because of the re-ratings by USDA’s Risk Management Agency, but not reflect any increase because of higher indemnity payouts from the 2012 drought. That may come in the 2014 crop year, along with even higher rates if Congress determines producers should pay a larger share of the premium.

Currently, USDA pays over 60 percent of the premium, compared to less than 40 percent in the early 1990’s, and many in Congress concerned about the budget want taxpayers to pay less. The debate over the next year could paint a different complexion for the crop insurance program, which could bring alternatives to the table for consideration. One of those is a plan that is modeled after health savings plans, which accumulate pre-tax funds to pay one’s own medical bills.

The same would be the case for a farmer who deposits pre-tax funds into a managed account to cover qualified crop losses.

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The Crop Insurance Savings Account program (CISA) is a risk management tool to protect against yield and revenue losses, smooth the farm income stream, and sustain the operation after a summer like 2012. The program would operate primarily on producer funds, not taxpayer funds, and unused money would become available to the producer following the end of a farming career. Instead of paying crop insurance premiums, at whatever rate, a producer would use those funds to manage risk in the case of a crop failure. The government would have a minimal role which would make the plan more palatable to critics of the current crop insurance program.

The concept is being promoted by a trio of agricultural economists from the University of Georgia, in part as a replacement for government subsidies, which they said were $36.5 billion over the past 10 years, plus another $12 billion to insurance companies to implement the program. They do not address the $16+ billion indemnity payments for the 2012 drought, but those include $6 billion in producer premiums received by the government. They believe if government subsidies increase, program opposition will increase, and subsequently change must be made.

The economists also say the insurance ratings, which determine premium levels, have been unfairly applied and ratings are not only disproportionate from one state to the next, but also from one farmer to the next even if they have the same yield and revenue risk.

They say based on the lack of federal funds to make the crop insurance program an adequate safety net, concerns the program cannot meet the needs of all producers, and the ratings variations, it is time to consider an alternative that is less cost to the government. The economists point to a number of similar programs that have been proposed. But in the CISA program federal funds would be available to fill in a gap should a producer not have enough in an insurance savings account to indemnify his crop loss.

The economists say their program would solve many criticisms of other proposals. “The proposed design should exhibit minimal moral hazard and adverse selection problems. As well, under the CISA system, farm-level risk would no longer have to be priced, thus eliminating the premium rating difficulties that weaken actuarial soundness and trigger the need for substantial external subsidies. In addition, administrative costs should be relatively small.”

Here is how it would work:

Withdraws from the account are made when farm revenues in a given year fall below a pre-specified threshold.

Once a balance reached a specified level such as 65 percent of a farmer’s 5-year revenue moving average, it would be capped.

Farmers who have a negative balance, and hence have borrowed money from the government, are required to temporarily contribute a higher percentage of their revenue than the pre-specified rate. It would be charged only in years when actual revenue exceeds the 5-year average.

Like a traditional individual retirement account (IRA), positive balances in CISAs may be withdrawn after retirement from farming or bequeathed to heirs in the event of death.

The viability of the proposed crop insurance system rests squarely on one issue: the proportion of farmers that will reach retirement with a negative account balance.

The economists developed a computer model for 10,000 farmers, testing five regular contribution rates equal to 1 percent, 3 percent, 5 percent, 7 percent, or 9 percent of a farmer's 5-year revenue moving average as well as three different revenue guarantee rates that are 65 percent, 75 percent, or 85 percent of that moving average. They found at a 9 percent contribution rate with a 65 percent revenue guarantee, the simulations indicate that only 2.85 percent of farmers would ever have a negative CISA balance and less than 0.005 percent would end with a negative balance. In the reverse case of a very low contribution rate of 1 percent and a high revenue guarantee of 85 percent, nearly all farmers will at some point need a loan from the government and over half would end with a negative balance. Participants on average have positive but moderate account balances upon retirement ($427, $461, and $449 per acre respectively).

But how does the cost compare to a crop insurance premium?

The University of Georgia economists tested their level of contributions with crop insurance premiums paid in Illinois. They found “the effective contribution rates corresponding to the above contribution and revenue guarantee combinations are 2.32 percent, 3.62 percent, and 5.92 percent of average annual revenue ($13.81, $21.60, and $35.25 per acre). As a point of reference, the 2007-2011 average crop insurance premiums paid by grain corn farmers (crop code 0041) purchasing revenue insurance products in the State of Illinois for the same revenue coverage levels, were $10.82, $15.43 and $29.27 per acre. Note that, although the effective crop insurance premiums are heavily subsidized by the government, they are not that much lower than the CISA contributions.” And they add, “As long as coverage levels are reasonably defined in terms of the frequency of loss they are designed to protect (e.g., 5, 10 or 15 out of 100 years) the proposed CISA system could provide effective coverage at affordable annual contributions regardless of how volatile a crop’s revenues are.”

And why would someone opt for CISA over crop insurance?

The economists report, “Because of insurer and producer uncertainty about what the actuarially fair premium is, without subsidies, many farmers would feel that they are being overcharged and thus not participate. Under the simplifying assumption that a producer would only purchase coverage if he or she thinks that the premium quoted by the insurer is fair or better, and moderate levels of uncertainty, substantial subsidies are needed to achieve high participation rates.”

2012 was one of those years when farmers in many areas actually collected indemnity checks, unlike many prior years when premiums were paid, just for the benefit of having insurance. The economists say, “Under the proposed CISA, since the producers would own and be paid interest on the contributions they make to their accounts and those contributions are tax-deductible, they are more likely to participate even if the required contribution rate is substantially higher than what they think it should be for the account to end with a positive balance.”

Summary:

A self-funded crop insurance system may be one of those proposals considered in the future as the nation wrestles with high levels of budget debt, while providing crop insurance to farmers. Such a program would parallel a health-savings account in which tax deductible funds are used for major medical issues. A crop insurance program would indemnify a producer with losses in yield or revenue below an established level. The producer would draw on the account in the event of a loss, and funds remaining when the farming operation concludes would be provided to him.